Debt-Equity Mix Simulation: El Caf

Essay by jarretperkinsUniversity, Bachelor'sA+, March 2006

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Debt-Equity Mix Simulation Summary


Finding the right balance is important. When talking capital structure decision, one must get the right blend of debt and equity. In this simulation provided by the University of Phoenix, I was asked to use the Weighted Average Cost of Capital (WACC), to find the optimal debt-equity mix for a café business known as El Café. During the simulation what seemed optimal at first was quickly changed in certain situations and a musical chairs with the debt-equity mix was the only way out.

Debt-Equity Mix Simulation Summary

The simulation starts out in an extremely popular coffee shop in Nicollet Mall in Minneapolis, Minnesota. The coffer shop, "El Café", has been doing very well with its mix of regulars and the owner has been thinking about expanding into a chain of coffee shops across the city. We know that expanding won't be easy because of the competition out there and because one will require much more money (UOP, 2006).

The first challenge was to first raise enough funds and financing to open an additional two coffee shops in the city, about $400,000. There were two options: The first came from Uncle Jorge Campos who is more than willing to invest in the business venture in return he wants to take charge in some of the key operations or use the special promotions being offered by the state such as zero taxes and low interest loans for small businesses. In this type of situation I decided it would be better to go with the low interest loans and change my debt-equity mix to 70-30%. By using this mix, I was able to achieve a WACC (Weighted Average Cost of Capital) of 8.65%.

What is WACC? Generally speaking, a company's assets are financed by...